In the 5 years since I last wrote about appraisals, a lot has changed—and such is the primary reason that I felt an update was in order. The Home Value Code of Conduct (HVCC) was enacted on May 1, 2009 to ensure the objectivity of the appraisals and to make real estate financing cheaper. The new regulation’s primary aim was to end what was deemed a potential conflict of interests between loan officers and appraisers. In the past, appraisers were heavily dependent on mortgage bankers and brokers for business and often felt pressured to support the value needed for a property to make the deal work because if they didn’t, the loan officer might not use them again. To ensure their livelihood, many of them accommodated loan officers by "stretching" their appraisal values.
In a perfect world, appraisers are supposed to function as an objective third party with no interest or connection to any person involved in the transaction other than to provide a quality appraisal. To alleviate this, the HVCC proscribed loan officers from ordering appraisals directly from appraisers. Nowadays, they are required to order appraisals via a lender’s Appraisal Management Company (AMC) which in turn randomly assigns an appraiser. The ideal is to provide an objective valuation even though every appraisal is subjective in nature.
While the goal of the HVCC was laudable—to ensure fairly-priced, objective valuations—it resulted in appraisals being more expensive and more inaccurate (than was formerly the case). Appraisals had been in the range of $300-$350, but with the introduction of an intermediary in the form of the AMC there was now an additional entity that needed to be compensated. Consequently, the cost of appraisals increased upwards from $385 to $450. Meanwhile, veteran appraisers saw their years of experience, professionalism and reputation rendered worth far less because they received only about $250, the balance going to the AMCs. Consequently, to offset their lost income, appraisals were frequently being done by "out of area" appraisers, unfamiliar with the neighborhoods and communities they were evaluating. Worse yet, borrowers were restrained from shopping for loans because the appraisals were (in most cases) no longer portable, i.e., lenders were reluctant to honor another’s lender’s appraisal.
WHAT’S ON AN APPRAISAL
When you first view an appraisal you may be overwhelmed by the welter of information that appears. While they are detailed, they are formatted in a very definite way which includes:
* The object of an appraisal is called the subject property.
* Details about the subject property, along with side-by-side comparisons of three similar properties.
* An evaluation of the overall real estate market in the area.
* Statements about issues the appraiser feels are harmful to the property's value, such as poor access to the property.
* Notations about seriously flawed characteristics, such as a crumbling foundation.
* An estimate of the average sales time for the property.
* What type of area the home is in (a development, stand alone acreage, etc.)
* Photos of the exterior and interior of the subject property, of street scenes, and of comparable properties.
RESIDENTIAL APPRAISAL METHODS
Of the three appraisal methods, only two are commonly used for residential properties:
Sales Comparison Approach
The appraiser estimates a subject property's market value by comparing it to similar properties that have sold in the area. The properties used are called comparables, or "comps".
The cost approach is most useful for new properties, where the costs to build are known. The appraiser estimates how much it would cost to replace the structure if it were destroyed.
This method uses the income stream or gross rents to determine the value of apartment buildings, shopping centers, office buildings, industrial properties and warehouses, resort and recreational properties, hotels, motels, and restaurants.
THE GOOD, THE BAD, AND THE GRID
A good appraisal supports The Three Cs of Appraising: Close, Current, and Clone. What this means is that comparable properties need to be Close (within a mile of the subject property). Additionally, the comps need to be Current (ideally within 6 months) and a Clone (with features similar to the subject property). A good appraisal has a relatively close range of values.
A bad appraisal displays The Three Ds of Appraising: Dated, Distant and Dissimilar. The three are the essentially the exact opposite of the three Cs. Dated meaning the sales comp is over 6 months old; Distant, more than a mile from the subject property; and Dissimilar in that the comps don’t share dominant features with the subject property.
The grid is typically located on page three of the appraisal and it is where the subject property is compared alongside three comparable properties and adjustments are made to bring them into parity. There are good and bad grid adjustments. An example of the latter would be an "across
the grid adjustments" that is, one wherein the subject property was located on a heavily trafficked street but none of the sales comps were. Sales comps with ocean views whereas the subject property had none would be another example of an "across the grid adjustment" that would indicate a poor choice of comps. It is the overriding aim of appraisals to compare like with like.
More than five adjustments in the 90% section (or from the basement up portion of a property) tends to be looked down upon because of the dissimilarity between the subject property and the comps chosen. The price range of the comps should also be within a relatively narrow price range, certainly no more than $50-75,000.
ADJUSTMENTS TO THE GRID
Although it’s desirable to compare "apples to apples", as discussed, no two properties are exactly alike, even homes with identical floor plans will have different views and traffic streets. As a consequence, adjustments need to be made to reflect variations between the subject property and the sales comps. This is done by making paperwork adjustments to the comps in order to make their features more in-line with the subject property's. The result is a figure that shows what each comp would have sold for if it had the same components as the subject property.
Adjustments are made either up or down depending on the property and the neighborhood. Sometimes homeowners over-improve their property relative to the neighborhood. A swimming pool would be an obvious example of upward adjustment. But an appraiser would not adjust for the full extent of its cost because many buyers do not want the additional expense of maintenance, and responsibility that goes with having one. A subject property may be adjusted down because of its floor plan or functional utility. An example of poor functional utility would be one in which a homeowner added a bedroom, but the only access was through another bedroom.
SO WHAT DOES THE APPRAISAL MEAN TO YOU?
A borrower’s loan approval is routinely obtained early in the loan process, but final loan commitment usually hinges on a satisfactory appraisal. The bank wants to be sure the collateral is adequate in case the borrower defaults on the loan.
If the property appraises lower than the sales price, the loan might be declined, but that isn't the only hurdle it must pass. Other facts on the appraisal can be a problem, too:
*The bank probably won't like it if the estimated time to sell the property is longer than the area average.
*If the appraiser notes that entry to the property is from a private, shared road the bank might want to see a road maintenance agreement signed by everyone who uses the road, verifying that maintenance is shared by all parties.
These are just a couple of examples of off-the-wall considerations that could hinder your purchase. The lender will study the appraisal carefully before determining whether or not the property qualifies to serve as security for your loan.
Appraisers make notations about obvious problems they see, but they are not home inspectors. They do not test appliances, look at the roof, check the chimney or do any other typical home inspection tasks. Never count on an appraisal to help you determine if the home is in good condition.
Appraisals for most homes are in the range of $350-$400, nowadays. Rent surveys and net income operating statements usually run an additional $300. Field Reviews and BPOs are in the neighborhood of $100-200. In most cases, the cost of an appraisal is designated as P.O.C. or Paid Outside of Closing because the appraiser expects to be paid for his work when it is completed rather than having to wait for an escrow to close. Because some (escrows) never do, appraisers often ask the mortgage broker or realtor to guarantee payment or require an additional $25 or $50 if they are to be paid at closing.
The one thing that astounds me is how many people pay for appraisals and yet never receive them. What I mean by this is that often times people come to me because whomever they were dealing with before was unable to complete the transaction. More often than not, although the client has paid for the appraisal the previous mortgage broker has not seen fit to forward one to the client. The fact that someone would pay in the area of $350 to $400 for something and yet never insist on receiving a copy of it is truly staggering to me.
There are many reasons to obtain an appraisal. The most common reason is for the purchase or refinance of real estate, but there are others. What follows is a list of reasons that you may not have thought of:
* to lower your tax burden
* to establish replacement cost of insurance
* to contest high property taxes
* to settle an estate
* as a negotiating tool when purchasing real estate
* to determine a price when selling real estate
* to protect your rights in a condemnation case
* because a government agency like the IRS requires it
* one is involved in a law suit e.g., a divorce.
Copyright © 2020 Rod Haase. All rights reserved.